Indeed, this is one of the dumbest rules. If they let the instruments to be played on playback then I see no difference in letting the singers sing on playback too. It would be good if this rule changed.
I'm not so much for the return of whole orchestra, because it simply isn't needed in most of the songs. However, it would be magnificent if they allowed real instruments on stage. The whole atmosphere just changes if everything's performed live. Besides that, I think that it would bring better and more known rock bands to Eurovision too. There's really no point of Coldplay (just an example, because they're known for their good live performances) participating on Eurovision, if they can't play the gig live.
With a real band on stage, Eurovision's status would definitely change. People wouldn't consider it as a "karaoke show" anymore.
It's a practicality problem. There just isn't time to arrange and tune instruments in the 30 seconds they have between each performance.
The only option, I guess, would be a revolving stage where the next couple of acts can be sorted out while other performers are singing. I don't think it's worth the bother or the backlash from angry bands if they get the sound wrong.
^^ They pretend that they are playing them.